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When US President Barack Obama announced in late January
his intention to seek tough new rules for banks, he was not
expecting to make friends on Wall Street. "We will
henceforth prevent banks from trading on their own account
and from growing too large," Obama declared.
The internal battle within the Obama administration seemed
to have been won by Paul Volcker, the impressive and
outspoken former Federal Reserve chairman who has long been
a critic of financial innovation.
Unsurprisingly, Goldman Sachs and other Wall Street firms
are dubious about the "Volcker rules." So, too, are the
Republicans in Congress, along with some Democrats who feel
that the scheme has come too late and may interfere with
other reform efforts underway, as watered-down as those
initiatives may be. Such domestic opposition weakens the
prospect that Obama's proposals will ever become law.
But the international reaction was less expected.
Obama's announcement received a decidedly unsympathetic
reception from Europeans, who perceived his initiative as a
unilateral move that would undermine international
coordination of financial regulation. The announcement had
come without international consultation. It also seemed to
violate earlier agreements to cooperate with other nations
through the G-20, the Financial Stability Board, and the
Basel Committee on Banking Supervision.
At the World Economic Forum in Davos, US Congressman Barney
Frank was surprised to discover that the greatest opposition
to us plans came from international regulators. The Obama
administration's proposed measures would simply create
"regulatory confusion," one of them complained.
This is a widely shared concern.
Financial Times columnist Martin Wolf accused the US of injecting "new and
unsettling ideas" into the discussion of financial reform.
Continental European countries like big banks and therefore
will never go along with the Volcker rules, he wrote.
Accordingly, these reforms "are going to prove inapplicable
outside the US and so create difficulties in international
coordination."
Dominique Strauss-Kahn, the managing director of the
International Monetary Fund, was uncharacteristically blunt
for an international official. Taking direct aim at Obama's
proposals, he argued that reform of the global financial
system should not be driven by what each country sees fit
for itself.
"We need to have coordination," he said. "We cannot afford
to have different solutions in different parts of the
world."
The chiefs of major European banks such as Deutsche Bank,
Barclays, and Société Générale were naturally also unanimous
in their hostility. Regulation that is not globally
coordinated, they warned, would create unnecessary
uncertainty, prolong financial distress, and threaten
economic recovery. And, oh, of course, it would cut into
their profits, too!
Global coordination, like global governance, sounds good.
But the practical reality is that it cannot deliver the
tough regulations, closely tailored to domestic economic and
political requirements, which financial markets badly need
in the aftermath of the worst financial upheaval the world
economy has experienced since the Great Depression.
In a world of divided political sovereignty and diverse
national preferences, the push for international
harmonisation is a recipe for weak and ineffective rules.
That is one reason why international bankers love
international coordination.
Many scholars of international relations consider the Basel
Committee on Banking Supervision, the international body of
regulators charged with devising a new set of global
standards, as the apogee of international rulemaking. Yet it
is surely telling that this will be the third version of its
guidelines in as many decades.
The last big idea the Basel Committee had was that large
banks should calibrate their capital requirements based on
their own internal risk models. But the dangers of
permitting banks to police themselves were made amply clear
in the latest crisis.
When financial regulations are devised by a coterie of
global regulators in distant venues, it is bankers and
technocrats who gain the upper hand. Returning the process
to national capitals would shift the balance of power to
domestic legislatures and national stakeholders. Bankers and
their economist allies may rue this, but it is as it should
be. Politicisation is the necessary antidote to technocrats'
tendency to be captured by banks. Democratic accountability
is our only safeguard against a return to light regulation.
Democratic accountability would also result in regulatory
diversity - different countries doing their own thing - and
that is not a bad thing, either. If the US wants to place
size limits and tighter capital requirements on banks, it
should be free to do so. If Europe wants to devise its own
rules for credit-rating agencies and hedge funds, it should
simply go ahead.
Naturally, regulatory diversity would require cross border
financial controls to ensure that banks do not evade
national regulations by operating from foreign
jurisdictions. The rule would have to be that If you want to
serve my market, you must play by my rules.
It is easy to be swayed by arguments about how costly such
market fragmentation would be. Deutsche Bank Chief Josef
Ackermann has gone so far as to warn that moving in this
direction would "leave us all poor."
Regulatory diversity is indeed costly for bankers, who
would have to adjust to differences in regulations across
national borders. But the rest of us suffer from too much
financial globalisation, not too little. Some financial
segmentation is a price well worth paying for stronger
regulations that are solidly backed by domestic politics.
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